Reforming local government finances in Cyprus

The local authorities in Cyprus have been in financial difficulties for many years and have been funded in part by the government via the annual grant. The grant is a source of funds that is allocated to municipalities based on their size and to the willingness of central government to continue to provide such assistance; it is not an obligation under the constitution or by legislation. The annual grant as is currently administered and decided is wholly insufficient and cannot be the basis of promoting healthier local government which every modern EU state has committed to institutionalise. The municipalities have no fiscal autonomy in Cyprus and have no way of increasing their revenues without Parliamentary approval. This state of affairs
cannot be sustainable as some municipalities are heavily burdened with debt and are unable to offer public services which Cypriot EU citizens deserve. The recent concerns expressed by two union leaders and their proposal to lobby central government for the annual grant to bail out the municipalities must not be allowed to derail the efforts the Minister of Interior to reform the local government in Cyprus. In fact, the need to review the local government self-­governance and fiscal autonomy must be studied and good examples of the Nordic countries be gradually introduced in Cyprus by way of legislation and where necessary by way of amendment of the constitution.

The magnitude of the financial situation has been reported to amount €300mln in outstanding debt and unfunded pensions amounting to €144mln. In the meantime, the quality of public services is declining in most local authorities. Development expenditure in local authorities is hostage to inadequate funding. The structure of local authorities in Cyprus is a remnant of the colonial government and it comprises of central government exercising control over local authorities. Fiscal autonomy is non-­existent and it is this reform that must be addressed by Parliament and central government. In the past both central and local government were willing to accept this situation for their own ends; Government political control over municipalities which Ministers and District Officers enjoyed given the rewards of such power. The local government leaders were uncomfortable to use taxes as their key source of own revenue and preferred instead to rely on central government grants. In fact, this state of affairs was clearly manifested in how municipalities were allowed to borrow for projects approved by central government and where the government contributed 3/5 or 4/5 of the repayment and also guaranteed the loans municipalities raised.

It is not too difficult to see that Mayors and local government officials were living in a comfort zone that meant central government was calling the shots and all local government had to do was to raise revenue at the margin in order to cover current expenditure, which in Cyprus is mostly the payroll. At one point some of the municipalities had 70-­80% of budgeted expenditure used to pay salaries;; in one case a relatively small municipality in Nicosia in terms of size had 3 times more staff than the largest municipality. There is definitely a need to reform local government in Cyprus but it must be to make local government become more autonomous and accountable. By making local government in Cyprus fiscally independent the range of public services to be offered must be agreed with central government. The most important change must be to enable local government to impose taxes on income and property as the core source of their own revenues. Central government and Parliament must seek real reform by looking at making local government fiscally autonomous otherwise most reform will fail. One model that is worthy of study is the Nordic Model of local government.

The Nordic Model has been developed through successive reforms. It was not built on a single blueprint or grand design, but has evolved gradually. And because parties from all sides of the political spectrum have contributed to the development of the model for many years, it is founded on a general consensus. All parts of society have played a part in this process. Labour unions, employers and cooperative movements have been heard, as well as represented, by their respective parties in cross party compromise that has characterized the Nordic Model; The countries that comprise the Nordic Model are Finland, Sweden and Denmark. The Nordic local governments are key providers of public services and have high degree of fiscal autonomy under supervision of central government. Local government in the Nordic countries have strong stand alone financial characteristics which has developed over many years of accountable and transparent management of their financial affairs. Despite their autonomy local government would have sovereign support in the event of financial distress.

The key role of local government in the Nordic countries is evidenced by the share of public expenditure they have as at 2014 (latest OECD data published) the following were their share:

Denmark 62%, Sweden 48% Finland 40% with OECD average at 24%.

Local governments in the Nordic countries have the right to impose taxes and these account for the majority of local government revenues with grants, fees and financial income covering the balance of expenditure. Taxes that are used include income tax, corporate tax and tax on land/property. Tax receipts as a percentage of municipal revenue varies from 70% in Sweden and Denmark to 40% in Norway. The strong stand alone financial position of local government in the Nordics is further supported by clear constraints on borrowing. The fiscal discipline which has been adopted provides for balanced budgets and where budgets are in deficit there is a remedy period of 3 years.

It must be clear from the above that for local government in Cyprus to attain fiscal autonomy and have a more systemic importance in the administrative structure of a modern EU state it has to dramatically change how it is organized and how it is controlled. It cannot be the case that political parties propose reform in Cyprus in order to paper over the need for fundamental reform. The Mayors and municipal councilors have not demonstrated over the years that they manage their financial affairs prudently and repeated reports of the Auditor general of the Republic have been ignored by Ministers and government in general. Without control and accountability there can be no reform. However, in order to promote the culture of working in the public interest it is very important that legislative changes are introduced gradually with a roadmap to make local government more important in the provision of public services, how these will be funded and how the local government will be accountable to the public via elections and for their management by Parliament and the Auditor General. If unions and local government officials are ready to be accountable it will mean that budgets will have to be managed in a manner that justifies taxing people and managing the revenues in a prudent way;; it cannot be the case, as unions suggest, that local government and central government support is to secure the jobs of the union members.

In Cyprus the case for reforming local government is long overdue and there is a danger that due to political maneuvering some may seek to paper over the real reforms that are needed. The truth is though that any piecemeal reform will not solve the financial weaknesses that are inherent in the current system. If the proposals for reform address the question of how local government becomes more accountable for gradual fiscal autonomy the government should take the initiative and invite the parties to an honest discussion setting out the benefits for reform; The Report of April 2014 produced by the UK School of National Government is a very good starting point. The real problem in Cyprus is that to introduce reform there are parties to the reform discussion that have their own agenda and do not see the public interest at large. Local government is not just to provide and secure jobs of union members but to provide local democracy with the power to provide the citizens with better public services and to fund this expenditure in a well-­managed manner. This will require a change of culture and to work in a consensual way and to have the reforms introduced in a gradual and measurable method. A Committee of Parliamentarians, local government officials and cross party members should be set up to monitor the progress and to report to Parliament and the Minister of Interior on an annual basis. The Auditor General should have a critical role to ensure compliance with best practice and to avoid any waste of public funds.

In view of the financial imperative of securing central government support the Minister of Interior should offer conditional support in the form of continuing the annual grant in exchange for the Union of Municipalities and the unions agreeing a roadmap to fundamental reform. The best way forward must be that the annual grant must be replaced by own revenues from taxation so the reform of local government will require the involvement of the Ministry of Finance agreeing to allow local government taking a larger share of tax revenues. This will mean more tax planning ahead will have to be made to enable these changes and it is for Parliament to agree since such changes will require fundamental legislative measures that have to be approved. If union members think that the public revenues can be used to cover their deficits without any reform, they must get a reality check. The only way is for government to legislate so repayment of outstanding debt has priority over payroll so that discipline is institutionalized. While this may sound drastic it is one step in the right direction which the citizens of municipalities will accept. It is not dissimilar to a household having to pay its debts first; Why should municipalities be different?

What about the number of municipalities? That should be the starting point of any exercise/attempt to reform this sector. We have way too many of them and this makes absolutely no financial sense. We should only have Nicosia, Limassol, Larnaca, Paphos, Famagusta and Kyrenia. Nothing else.

Yes the numbers could be reduced but this will not give the municipalities more fiscal autonomy as the savings will be inadequate to provide the public services they need to offer. The key is to make them independent, as much is feasible, accountable, working according to best practice and justifying their expenditure to tax payers via the ballot box.

Yes, the municipalities should be no more than say, five. It is purely uneconomical and makes no sense at all. Yes, the municipalities should be independent and self sufficient, taking care of their own (easier said than done). But most of all, the municipalities should de-politicized. The political parties should not command who gets on the Councils and who and how he/she pays back the favour for supporting them and getting them elected.

Dear Savva,
One of the main principles of the EU is to give more importance to participatory democracy and at the local government level. This has a measure of success in many northern European countries as it has led to more transparency and accountability. By reducing the number we may be moving to the old British model of central government dictating how money is spent for public services which has led to very poor public services in the UK. Whilst we may wish to have fewer municipalities this in itself will not lead to the vision of having better local government in terms of fiscal autonomy and discipline in how they manage their affairs. The Auditor General can exert great etc control going forward on both.
Whilst we may all feel there is unnecessary duplication of local government services with so many of them I would rather seek to reform local government based on models that have succeeded via evolution and compromise; such reform may mean rationalisation and fewer municipalities but hard to see that being reduced to five.

We have to take into account the economies of scale, our cities are simply too small to support more municipalities (I do have to admit that this is a gut feeling that is not based on any scientific evidence and will change my mind if there is supporting data/evidence). When establishing policies and plans, the municipalities need to be able to do so for a whole city and not for parts of a city.

If the reform of the local government was simply to reduce the numbers this could be achieved to reduce duplication of services and reduce the payroll. But is this the reform we should seek? Economies of scale are not reform that will make the revenue raising powers of local government support their roadmap to fiscal autonomy.
As Savvas suggests in order to have less central government political influence there is a need for local government to assume more responsibility for its expenditure and revenue raising sources that are sustainable. Short of this the local government will always depend on central government hand outs. The debts of municipalities only include the amounts actually borrowed but not the liabilities in respect of pensions as these are on the whole unfunded. So in my humble opinion more accountability and autonomy with broader revenue raising can be good for the local government EU citizens of Cyprus deserve. If we do not want to have better local government then we should shelve reform for the next generation. One hopes the new Minister of Interior, who is very well informed about the reforms needed, will promote such reform.

To rephrase a previous post of mine, yes I do agree that the municipalities need to own both their Balance Sheet and their P&L. But it makes absolutely no sense to have so many municipalities, so the first step should be to merge them, 1 for each province is more than enough, and then move forward, it is counter intuitive to do it otherwise.

Nefeli, I do agree that municipalities are rather small and need to be merged to have more economies. However, the question is whether this is sufficient reform to make the local government independent, accountable and more efficient in the financial management?

I agree with Mr Savvides that the municipalities should be de-politicized and that political parties should not command who gets on the Councils etc.
Unfortunately this will never happen in Cyprus, at least not in our life-time.

As for the Nordic model of local government that Mr Erol Riza suggests,
I am totally in favour . – provided we import Mayors and local councillors from the Nordic countries.
But on the whole, the article of Mr Riza highlights a major problem that local authorities are facing and proposes sound solutions that the Minister of Interior, (whoever he/she might be) should be well advised to consider.

One idea could be the separation of the provision of services and the existence of Municipalities. Taking Nicosia for example services could be provided by a greater Nicosia entity, perhaps called council to prevent confusion, controlled by a board on which the municipalities are represented according to size. The existing system of municipalities could remain with some reform. This level of local government would thus represent principally their municipality in the greater Nicosia entity and have some small funds for local cultural events.

As to the funds for the greater Nicosia council and the municipalities there is already an annual charge based on property. This could be expanded to replace the property tax which was recently rather strangely abolished.

As to the debts of the municipalities these should be examined to see what went wrong and who was to blame and the blame publicly assigned and were warranted proceed to criminal proceedings.

i have the feeling that municipalities often hesitate to do their job, suggesting its the job of the police etc., so as not to antagonize the electorate. E.g. with respect to blocking pavements with signs etc..

I believe that the opinion and comments miss one major fact, which is what local government is responsible for.

In the Nordics, which the opinion suggests as a model, local government runs social services, including elderly services, services for disable people, individual and family services, pre-school and compulsory and upper school education, planning and building matters, environmental and public health protection, refuse collections and waste management, water and sewage, rescue services, civil defence, library services, housing, hospitals, health and medical care, dental care, local public transport and these are just the mandatory. Some of them even do culture, education, tourism, energy, etc.

So define services first, define cost of delivering those services and then start talking about imposing taxes on income and property, which by the way will drive inequality higher in no time.

As to the number of municipalities offering the above services, the sweet spot for Cyprus is 18. Small enough for management to know what is going on, large enough to stop management from creating bureaucratic processes.

BTW, social services are not designed for economies of scale. When I read about economies of scale in government, this is neoliberal speak for reduced social services. And then they complain about crime, drugs and cities that are falling apart.

As far as concerning comments about de-politicizing local government, I believe that it is best to give an example first.

Mr Savvides, with all due respect the Nordic model was cited as an example for fiscal autonomy and id not suggest that Cyprus municipalities offer the same services. I think that it would be useful to have your views on what you think reform of local government should entail having in mind the financial mess they have chronically been in. Other than having power to raise revenue, and possibly cut cost by rationalisation, how will pensions be paid and better services? If you think they should rely on handouts then this is not autonomy or independence. The EU places a lot of emphasis on regional and local government as conduits for local democracy which I hope you espouse.

The reason municipalities are in a mess is because they borrowed for capital expenditure. Their accessory to this crime was the government through the ministry of interior which was co funding the capex and the local coops who thought they found the village idiot to lend to.

I like your comment on municipalities pensions. Have you seen the €450 million we waste yearly on government employees pensions? Add personal income tax and local companies income tax yearly and you are still short.

I believe that local municipalities should offer social services. They should be funded based on the real needs of the people they service. No capex, only operating expenses.

A higher level of regional local government should distribute EU funding and decide on capex. Acts as the focal point for administrative jurisdiction. No need to go to the central government for every license or certification, etc. Funding based on the number of people at each region.

All funding from central government.

I am all for local democracy, this is why I am a vocal supporter of referendums at all levels of government.